China's booming budget hotels profit from no frills

SHANGHAI (Reuters) - German engineer Michael Bosch is not fazed by the lack of a gym and other creature comforts at his budget hotel in a converted Shanghai office building. He’s stayed at such hotels on nearly a dozen trips to Chinese cities.

A maid pushes her cleaning cart as she cleans rooms at the Home Inn budget hotel in Shanghai January 5, 2008. Fuelled by tourism and expanding highways, the number of budget hotel rooms in China has mushroomed from practically zero to over 100,000 in eight years, offered by more than 100 brands. REUTERS/Nir Elias

“All I need is a clean, warm place to sleep. I don’t care so much about service,” the 32-year-old said as he waited for 10 minutes for a distracted receptionist to attend to him at a Motel168 on the edge of Shanghai’s financial district.

Millions of businessmen and tourists, both Chinese and foreign, are taking advantage of a boom in China’s budget hotel industry, which offers rooms for less than $50 a night compared with around $200 at five-star hotels.

The number of budget hotel rooms has mushroomed in the past eight years from practically zero to over 100,000 with more than 100 brands competing for a bite of China’s rapidly expanding domestic tourism market. More than a 100 brands have emerged.

The fast-developing Chinese budget hotel industry resembles the U.S. motel boom of the 1950s, which was fuelled by tourism and expanding highways.

“China has a population four times that of the U.S, and the potential to be the world’s biggest budget hotel market,” said Wang Lie, chief financial officer at budget chain Hanting Hotels.

Big and small Chinese investors, plus foreign heavyweights such as Morgan Stanley, Warburg Pincus and Merrill Lynch, are piling into the industry, even though fierce competition and sinking room rates now threaten to hurt profits.

Political and social change, as well as China’s economic boom, have aided the industry. Until recently, the government did little to encourage domestic travel by its citizens, partly because of concern about public security and social stability.

Many Chinese travelers had to stay at grim “guest houses” run by local governments, notorious for spartan dormitory rooms, lack of heating and poor plumbing.

But in 1999, the central government began promoting travel as a way to stimulate the economy, creating three week-long national holidays that boosted demand for hotel rooms.

That unleashed a travel boom. In 2006, 1.39 billion domestic trips by Chinese tourists generated $85 billion, up 17 percent from 2005, the latest official data shows. Industry sources say growth continues at a similar pace.

GOVERNMENT POLICY

China’s business travel market is worth about $10 billion, the world’s fourth biggest, according to American Express.

The Olympic Games in China this August, and the Shanghai World Expo in 2010, are expected to help keep demand growing after Beijing decided last month to cut the number of week-long holidays from three to two.

“Money has been pouring into this red-hot industry and every player is expanding aggressively for market share,” said Xu Rongzu, president of Shanghai-based Jinjiang Inn, which was founded in 1996 as China’s first budget hotel chain.

In contrast to luxury travel, China’s budget hotel industry is dominated by local brands. Though cheap hotels have lured budget tourists and backpackers from abroad, the vast majority of customers are locals who are unfamiliar with foreign brands.

Small, quick-footed Chinese firms have been able to dive into the market while potential foreign rivals are still doing feasibility studies, as average investment in a budget hotel is just $1 million and can often be recouped in three to five years.

The industry has drawn Chinese entrepreneurs including Ji Qi, 42, the crew-cut, fast-talking son of a farmer. He quit his job as a computer sales manager in Shanghai in the mid-1990s to travel in the United States for a year, before returning to establish a string of firms.

He co-founded online travel agent Ctrip in 1999 and Home Inns, now China’s biggest budget hotel chain, in 2001. Both are listed on the U.S. Nasdaq market. Ji now aims for an overseas listing of Hanting Hotels, which he set up in 2005.

Ji says the budget hotel industry is attractive because the country is shifting from a growth model of “Made in China” to “Service by China,” as pollution and international trade tensions mean it can no longer rely solely on manufacturing growth.

FOREIGN INVESTMENT

The dominance of Chinese entrepreneurs has left private equity investment in local firms as the easiest way for many foreign investors to get into the boom.

Home Inns raised over $109 million in its October 2006 Nasdaq listing after investment from U.S.-based venture capital firm IDG Ventures. It plans to quadruple the number of its hotels to 1,000 in a few years and expand outside China into Asia.

Shenzhen-based 7 Days Inn, China’s fifth biggest chain, plans to triple its number of hotels to 200 in 2008 after receiving in September a combined $95 million injection from Merrill Lynch, Deutsche Bank and Warburg Pincus.

But some big foreign chains think they have the expertise to compete in China, where establishing a name could help them attract business abroad from the hundreds of thousands of Chinese tourists starting to travel overseas.

Accor, Europe’s largest hotelier, aims to have as many as 120 Ibis budget hotels in China by 2010, up from nine now — though most of Accor’s Chinese revenue will still come from its higher-end Sofitel and Novotel hotels.

As with many Chinese industries, the investment boom may lead to a shake-out. Competition for customers and well-located properties is driving up operating costs while hurting rents and occupancy rates.

Room rates for budget hotels fell 45 percent on average in 2006 and occupancy slid to 82.4 percent from 89 percent, the most recent commerce ministry data shows — though that remained above the hotel industry’s average occupancy rate of about 60 percent.

Property rents, a big part of costs, rose five times faster than China’s already-frothy real estate prices in 2006.

The market has also been hurt by many substandard, privately run hotels which have been able to call themselves “budget chains” because of lax government regulation, said Zhang Minghou, an official at the China Hotel Association.

Zhang helped draft rules, to be published this year, designed to regulate the sector and service standards.

“China is no longer virgin territory for budget hotels, and the days of fat profits are over,” said Ji Yue, director of U.S. private equity firm Sequoia Capital. “There are already some obvious market leaders. We expect to see consolidation.”

Home Inns, Motel168 and Jinjiang Inn, which is part of the Shanghai Jinjiang International Hotels Group, already control a combined 44 percent of the market, and that may rise.

In October, Home Inns obtained 26 more hotels by purchasing two-year-old rival Top Star. Chief Executive Officer David Sun has said acquisitions will account for a fifth of Home Inns’ expansion in the long term.

But other chains may still thrive through market segmentation, said Wang at Hanting Hotels. “The potential in China is enormous, and it’s not a winner-takes-all game.”

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To avoid direct competition with leading players, Hanting calls itself a “mid-level” hotel chain and targets business travelers in particular.

Its hotels are decorated with oil paintings and each room is equipped with not one but two internet broadband lines.

And Malaysian-controlled cruise operator Star Cruises has entered the market by targeting the lower end, charging travelers less than $14 yuan per night compared with more than twice that at Home Inns.